News of Note

Income Tax Severed Letters 25 January 2017

This morning's release of seven severed letters from the Income Tax Rulings Directorate is now available for your viewing.

North Shore Power - Tax Court of Canada finds that HST was imposed on a customer through the issuance to it of a credit note by an insolvent supplier

A supplier (Menova) received substantial down payments (described as “deposits”) respecting its sale of solar array projects, and then became insolvent before earning more than a fraction of the down payments. Menova then issued “credit memos” to the business customer (North Shore) for the value of the unperformed work, and was petitioned into bankruptcy.

CRA’s position was that the HST included in the credit memos was required to be added back to the net tax of North Shore (thereby effectively reversing the input tax credits previously claimed by North Shore). North Shore argued that “a mere recording of the credit does not meet the test” of a credit note (an argument which was modestly supported by Compagnie Minière Québec Cartier). In rejecting this submission, Bocock J adopted a much broader meaning for credit note, viz. “a note issued by a business indicating that a customer is entitled to be credited by the issuer with a certain amount.” The upshot was that North Shore effectively was denied ITCs for HST that it had incurred for clear commercial purposes (although, to mention another issue, ITCs are only available under s. 169 where property or services have been "acquired.")

In passing, Bocock J also found that the “deposits” were not deposits for HST purposes, stating that they did not represent “payment of earnest money to guarantee the completion of the contracts.”

Neal Armstrong. Summaries of North Shore Power Group Inc. v. The Queen, 2017 TCC 1 under ETA s. 232(3), s. 231(1), s. 168(9).

The Canadian securitization markets have largely settled on a preferred structure for each type of securitized instrument

The most commonly-used lease securitization structure in recent years entails the leased equipment being dropped down to an LP under s. 97(2), with that LP issuing asset-backed notes, either directly to investors or to a conduit trust (that in turn issues commercial paper to investors) - and with that LP using such proceeds to repay a note issued by it on the drop down or returning partnership capital to the lease originator. Because of potential benefits of the LP being a principal business partnership and since the principal leasing business requirement must be met throughout each taxation year “it is common to transfer a few leased pieces of equipment to the [LP] at the time of its formation.” However, principal business partnership status may be in question if the lease originator retains some leased equipment and this is considered to be a business separate from its leasing business carried on “through” the LP.

Where mortgages are securitized by selling undivided co-ownership interests in the pool, the Reg. 7000(2)(b) interest accrual rules typically apply because the co-ownership interests give rise at various times to non-pro-rata entitlements to the mortgage interest that is collected. Although technical difficulties can arise respecting whether these interest accrual rules can dovetail with the net interest income being reduced by servicing fees:

A practical approach is for the certificate holder to report the net amount received and compute the prescribed-debt obligation accrual on the basis of the net amounts. The CRA agrees with this position.

“No significant assessments have come to light in connection with the treatment of the servicing...since...Canada Trustco” (which found that the sale of mortgages on a fully-serviced basis was a single financial supply).

There is a potential conflict in structuring a trade receivables securitization between providing for a true sale and permitting bad debts to be claimed for GST purposes by the vendor.

Neal Armstrong. Summaries of Sabrina Wong and Sania Ilahi, Tax Implications of Asset Securitizations, 2015 CTF Conference Report under Reg. 1100(16), Reg. 1100(2.2)(f), Reg. 7000(2)(b), s. 12(9.1), ETA s. 123(1) – financial service, s. 9 – computation of profit, ETA s. 231(1).

CRA provides an example of the election to claim medical expenses (that are not a prepayment for a future year’s services) on a lagged basis

After noting that fees (e.g., to a dentist) will not be recognized as medical expenses until they are incurred (i.e., the related services are performed (so that, for example, fees prepaid in 2015 for services to be performed in 2016 would not qualify as medical expenses in 2015), CRA went on to confirm (somewhat contrary to an earlier “confusing” 2005 technical interpretation) that for purposes of computing the medical expense tax credit ("MEC") in s. 118.2(1) for a year, an individual may choose any 12-month period ending in the year, but that the medical expenses must have been paid during the period so chosen. For example, if dental fees were paid on December 31, 2015, they would not be eligible for the METC computation for the 2016 taxation year if the individual had selected the calendar year, but such fees could be included in the computation of the METC in the 2016 return if the selected period included December 31, 2015.

Neal Armstrong. Summaries of 6 December 2016 External T.I. 2015-0589041E5 Tr under s. 118.2(1) and s. 118.2(2)(a).

TransAlta Corporation’s proposed restructuring of its preferred shares would let holders choose between a taxable exchange and s. 51 rollover

TransAlta Corporation currently has five series of Preferred Shares outstanding (Series A, B, C, E and G) which are trading at a substantial discount to the $25.00 price at which they originally were issued. TransAlta is proposing a Plan of Arrangement under which the holders of each series would exchange each of their current shares for a fraction of a new series of preferred shares (also with a redemption amount of $25.00 per share). These Series 1 Preferred Shares are expected to trade closer to $25.00 on the basis of more favourable dividend terms, so that TransAlta anticipates that the preferred shareholders’ holdings will trade higher even though there would be a reduction in the redemption amount of their shareholdings.

The preferred shareholders are given the option of having their exchange occur on a taxable basis (rather than on a non-disposition basis under s. 51) by permitting them to elect to have each share exchanged for a “Redemption Note,” which would then be immediately exchanged under the Plan of Arrangement for the proffered fraction of a Series 1 Preferred Share.

Neal Armstrong. Summary of TransAlta Corporation Circular under Other – Recapitalizations or note/pref exchanges – Prefs for prefs.

CRA discusses the interrelationship between s. 15(1.4)(c) and s. 246(1)

Opco is held somewhat equally by three holding companies, each wholly-owned by an individual (A, B or C) who is unrelated to the others. Opco sells an asset to B’s child for 1/2 its fair market value. CRA found that:

  • If the benefit conferred by Opco on B’s child was not also indirectly conferred by B’s holding company (Holdco B) on B or B’s child, then such benefit would be deemed by s. 15(1.4)(c) to be a benefit conferred on Holdco B by Opco, so that it would be included in Holdco B’s income.
  • On the other hand, if the benefit had been indirectly conferred by Holdco B on B or B’s child (which CRA would generally infer if Holdco B influenced Opco’s conferral of the benefit), s. 246(1) could apply to include the benefit in B's income.
  • If Holdco B had concurred in the benefit conferral, s. 56(2) could be an alternative basis for including the benefit in Holdco B’s income.

CRA did not discuss what criteria it would apply to determine whether it would assess Holdco B, or B, for the benefit (or even do both).

Neal Armstrong. Summaries of 6 December 2016 External T.I. 2016-0666841E5 Tr under s. 15(1.4)(c) and s. 56(2).

Société générale valeurs mobilières – Federal Court of Appeal finds that a Brazilian tax sparing provision did not permit the taxpayer to shelter Canadian-source income

Did a tax sparing provision in the Canada-Brazil Treaty, which deemed a Canadian taxpayer to have paid 20% Brazilian withholding tax on interest received by it from Brazil, have the effect of providing to it a Canadian foreign tax credit equal to the amount of that fictional tax, even though its effective Canadian tax rate on that interest income was much lower than 20% (perhaps because of applicable leverage)? This question turned on the meaning of a proviso in the Treaty, which stated that the FTC otherwise required by the Treaty to be accorded by Canada:

shall not… exceed that part of the income tax as computed before the deduction is given, which is appropriate to the income which may be taxed in Brazil.

Paris J, in rejecting the taxpayer’s position (and affirming the Crown's position that the FTC effectively should be limited to the low effective Canadian tax rate on the Brazilian interest income), had stated:

…The proper test for determining which amounts of the Canadian resident taxpayer should be included or deducted from the gross interest arising from sources in Brazil is that found in subsection 4(1) of the Income Tax Act.

This was confirmed by Woods JA, who stated:

[T]he ordinary meaning of the text takes into account not only the gross income which may be taxed by Brazil, but also the actual Canadian tax as computed under the Income Tax Act, which is based on net income.

Neal Armstrong. Summary of Société Générale Valeurs Mobilières Inc. v. The Queen, 2017 FCA 3 under Treaties - Article 24.

CRA comments favourably on a safe income strip using a preferred share stock dividend

Opco pays a stock dividend on its common shares (having a nominal paid-up capital and adjusted cost base) held by Holdco. The stock dividend is comprised of preferred shares with a nominal paid-up capital and a redemption amount equal to Opco’s safe income of $700,000. Opco then redeems the preferred shares for $700,000 and Holdco sells its Opco common shares to a third party for proceeds that reflect the $700,000 strip.

CRA indicated that s. 55(2) would apply to the preferred share redemption if the Part IV tax exception did not apply. However, given that the amount of the preceding stock dividend would be deemed by 55(2.2) for various s. 55(2) purposes to be $700,000, that amount would come out of the safe income of Opco under s. 55(2.3)(b) which, in turn, would mean that the cost of the preferred shares to Holdco would be deemed by s. 52(3)(a)(ii) also to be $700,000.

Accordingly, the application of s. 55(2) to convert the deemed dividend arising on the preferred shares redemption into proceeds of disposition would not result in any capital gain, given the stepped-up tax basis in the redeemed shares.

Neal Armstrong. Summary of 12 December 2016 External T.I. 2016-0668341E5 Tr under s. 55(2.3)(b).

CRA states that co-owners of specified foreign property with aggregate $100K cost amounts have T1135 reporting obligations even if they did not contribute to a particular property

Does a taxpayer with a joint interest in specified foreign property but who did not contribute to its acquisition, e.g., a child who was added as joint owner for estate planning purposes, have a reporting obligation? In the joint ownership case, must the taxpayer be the beneficial owner or would strictly legal ownership require reporting? After stating that the term “specified foreign property” in s. 233.3(1), which refers to property “of” a person or partnership, means property “owned” by the person or the partnership, and after referencing its discussion in S1-F3-C2 of beneficial ownership, CRA answered the first question (but seemingly not the second) as follows:

[A] reporting entity would typically be the owner (including a beneficial owner) of the property whether such ownership is jointly with another person or otherwise and irrespective of the financial contribution made by the reporting entity towards the acquisition. In the case of joint ownership, each reporting entity would report their ownership interest in the specified foreign property (i.e., if the total cost amount of specified foreign property to the entity exceeds $100,000).

Neal Armstrong. Summary of 9 December 2016 External T.I. 2016-0639481E5 under s. 233.3(1) – specified foreign property.

Income Tax Severed Letters 18 January 2017

This morning's release of six severed letters from the Income Tax Rulings Directorate is now available for your viewing.

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